The option value is the difference between the intrinsic (stand-alone) value of an opportunity and the value that becomes available through alternatives. The application to unconventional resource plays is that they unique characteristics that may lead to increased option value potential. These include significant uncertainties (volatility), long time horizons, market liquidity, ownership options, and large up-front investment requirements. Here we share a case study on a resource development program.

1. Leveraging the Option Value of
Unconventional Resource Projects
Unconventional Resources Technology Conference
Denver, Colorado
12 – 14 Aug 2013
Paul D. Allan
Partner
STRATEGY. DECISIONS. SUCCESS.

2. Leveraging the Option Value of
Unconventional Resource Projects
Option Value: The difference between the intrinsic (stand-alone)
value of an opportunity and the value that becomes available
through alternatives.
Development plans
Service
costs $
Timing
The option value increases
with the level of volatility
Net
Present
Value
Intrinsic
Value
(cash flow analysis)
Net
Present
Value
Capital
environment
Net
Present
Value
Net
Present
Value
Product
Ancillary
prices
investments
Timing
$
Exit
$Regulatory
strategies
constraints
Ownership
structures
Option Portfolio

3. Leveraging the Option Value of
Unconventional Resource Projects
Option Value: As compared to expected value
Option to develop HBP assets
What is the
‘Option Value’ of
these assets?
If new pipeline approved: NPV of Assets = $3.0 MM
If pipeline not approved:
NPV of Assets = -$4.0 MM (loss)
Assume 50% chance of that Gov’t will block approval
Option Consideration
Expected Value
50%
$3.0 MM
50%
Value = 0.5 x 3.0 = $1.5 MM
EV= - $0.5 MM (loss)
50%
($4.0 MM)
$3.0 MM
50%
$0 MM
Exercise option to
stop or defer
Option Value = - $0.5 MM + $1.5 MM = + $1.0 MM
Could pay up to $1.0MM for this option

4. Leveraging the Option Value of
Unconventional Resource Projects
Application to Unconventional Resource Plays: Unique
characteristics that may lead to increased option value potential
• Significant uncertainties (volatility) – Impact of new
technology, pricing, regulatory frame, availability of
services, costs, …
• Long time horizons – Significant exposure (opportunities) over time
• Market liquidity - Small and large investors – robust activity
• Ownership options
• Large up-front investment requirements
Potential Option Value

5. Option Value of Unconventional Resource Projects
Case Study
Resource development program: Simple example (representative)
– Based on dynamic portfolio model of assets
– Focused on single, new area development
– Integrated performance metrics for representative start-up company
Project ‘A’
• Leasing
• 2 Year Pilot (6 wells per year)
• Phase-1 Development (capture): 3 – 6
years (1 – 2 rigs)
• Phase-2 Development (infill): 0 – 5
years (1 – 2 rigs)

6. Option Value of Unconventional Resource Projects
Case Study
Resource development program: 3 Sources of Option Value
1.
Pilot program: Value of information gained in the first year – Option to stop
Results in 50% higher value realized from pilot
2.
Uncertainty considerations: Stochastic ranges alter the decision space
Increase of > 6% in total program value
3.
Strategic options – Value trade-offs in meeting performance deliverables:
Option value as driven by company objectives
Project ‘A’
• Leasing
• 2 Year Pilot (6 wells per year)
• Phase-1 Development (capture): 3 – 6
years (1 – 2 rigs)
• Phase-2 Development (infill): 0 – 5
years (1 – 2 rigs)

7. Option Value of Unconventional Resource Projects
Case Study:
Conditional dependencies
1. Pilot Program: Value of information
•
Two year pilot program (6 wells per year)
•
Pilot Costs (per year): Success = $51 MM, Failure = $25.5 MM. Success NPV = $72.3 MM
•
Probability of success (viable development) = 50%
•
If year one succeeds, probability of year two success increases to 75%
75%
Success
$21.3
50%
$21.3
25%
($25.5)
Expected Value Analysis
NPV (yr1) = -2.1
+ NPV (yr2) = 0.50 (9.6) + 0.50 (-2.1) = $1.7 MM
Fail
50%
$21.3
($25.5)
STOP
($2.1)
50%
Year 1
NPV (yr1) =
NPV (yr2) = 0.5 (21.3) + 0.5 (0 – 25.5) = ($2.1 MM)
$9.6
($2.1)
50%
Without dependency
Including dependency AND option to stop
NPV (yr1) = -2.1
+ NPV (yr2) = 0.50 (9.6) + 0.50 (0) = $2.7 MM
($25.5)
Year 2
Expected Value

8. Option Value of Unconventional Resource Projects
Case Study:
Conditional dependencies
1. Pilot Program: Value of information
•
Two year pilot program (6 wells per year)
•
Pilot Costs (per year): Success = $51 MM, Failure = $25.5 MM. Success NPV = $72.3 MM
•
Probability of success (viable development) = 50%
•
If year one succeeds, probability of year two success increases to 75%
75%
Success
$21.3
50%
$21.3
NPV (yr1) = -2.1
+ NPV (yr2) 0.50 (9.6) + 0.50 (-2.1) the MM
Could give =away year one of = $1.7pilot
$9.6
(or pay up to $4.8MM) for the data
25%
($25.5)
Fail
Including dependency (option to stop)
50%
($25.5)
STOP
50%
Year 1
Without dependency
NPV (yr1) =
Maintain flexibility in deals to leverage
NPV (yr2) = 0.5
option value (21.3) + 0.5 (0 – 25.5) = ($2.1 MM)
($2.1)
50%
Expected Value Analysis
Year 2
NPV (yr1) = -2.1
+ NPV (yr2) = 0.50 (9.6) + 0.50 (0) = $2.7 MM

9. Option Value of Unconventional Resource Projects
Case Study:
Uncertainty Considerations
2. Uncertainty considerations:
Value in combining stochastic
analysis, dependencies, and alternatives
•
Full development value chain: Leasing – Pilot – Development Phase 1 – Phase 2
•
Timing and conditional dependencies included for all cases

10. Option Value of Unconventional Resource Projects
Case Study:
Uncertainty Considerations
Free Cash Flow ($MM)
Project ‘A’
350
300
250
200
150
100
50
Assess
Risks
Timing / Regulatory
Reservoir
Tech Application
Production Profile
Costs
Pricing
Infrastructure
Services
Dev – Phase 1
Tech Application
Production Profile
Infrastructure
Costs
Pricing
Services
Dev – Phase 2
Costs
Pricing
Services
2023
2021
2019
2017
-100
2015
-50
2013
0

11. Option Value of Unconventional Resource Projects
Case Study:
Uncertainty Considerations
Full development (Accelerated Program)
•
•
Mont Carlo simulation – Stochastic analysis across all variables
Initial production rates drive value for program as considered
NPV Sensitivity to Input Variables
($MM)
0
IP - Phase 1
500
1,000
1,500
2,000
3.600
8.400
Basis Price - Oil
81.71
98.29
IP - Phase 2
2.400
4.800
LOE
12.21
7.79
Cost - Phase 1 Dev
111.950
92.050
Cost - Phase 2 Dev
96.633
83.367
IP - Pilot
0.944
1.456
Cost - Pilot Program
55.975
46.025
Downside
Upside

12. Option Value of Unconventional Resource Projects
Case Study:
Uncertainty Considerations
Developed simple stochastic representations
•
•
•
Integrated scenarios for each development program
Production / cash flow models developed for range of Initial Production rates
Assumed perfect correlation across each phase of development
IP
(bopd)
Resources
(MMboe)
NPV
($MM)
High
7,200
9.4
257
Most Likely
4,800
7.2
187
Low
3,600
7.2
78
30%
40%
30%
Integrated scenarios:
Each outcome reflects a
single rig-year (12 wells)

13. Option Value of Unconventional Resource Projects
Case Study:
Uncertainty Considerations
Decision Units: Opportunities available for selection
•
•
Includes dependency chains: Conditionals, Timing
Includes drill pace optionality: 1 – 2 rigs per year for each development program
Project
MB-Lease
MB-Pilot-IN
MB-Pilot-Yr1
MB-Pilot-Yr2
MB-Pilot-EXIT
MB-Phase 1 Dev-IN
MB-Phase 1 Dev
MB-Phase 1 Dev-EXIT
MB-Phase 2 Dev-IN
MB-Phase 2 Dev
MB-Facilities-1
MB-Facilities-2
2013
1.00
2014
2015 2016 2017 2018 2019 2020
Initial Lease Investment of $15MM
1.00
1.00
2021
2022
2023
Two Year pilot program (conditional dependencies)
Each modeled as a
1.00
simple stochastic Option to Sell following Pilot: Monetize value from de-risking
time
1.00
series
Assumes Acquisition cost equal to Pilot-Exit sale price
1.00
2.00 2.00 2.00
Option to sell following Phase-1 Development 1.00
1.00
Option to buy into Phase-2 Development -– set equal to- previous sale price
2.00 2.00 2.00 2.00 2.00
Facilities expansion projects – to increase take-away capacity
1.00
(representative ‘option’ to sell more product in the future)
1.00

14. Option Value of Unconventional Resource Projects
Case Study:
Uncertainty Considerations
Program Optimized
Without Uncertainty
Objective:
Maximize NPV
Constraints: Export Capacity as defined
IRR = 18%
NPV = $504MM
Assess + Dev (Phase-1) + Dev (Phase-2)
Facility-1 investment (only)
“Most Likely’ scenario would not require
investment in Facility-2
Constraint
Expected Value

15. Option Value of Unconventional Resource Projects
Case Study:
Uncertainty Considerations
Same project selections
With uncertainty ranges
Objective:
(DETERMINISTIC)
Constraints: Export Capacity as defined
Limited by Export Capacity
Facilities-1 investment (only)*
Exceeds Export capacity limit when
uncertainty considered
P10
Expected Value
P90

16. Option Value of Unconventional Resource Projects
Case Study:
Uncertainty Considerations
Program Optimized
With consideration of uncertainty ranges
Objective:
Maximize NPV
Constraints: Export Capacity as defined
IRR = 20%
NPV = $661MM
Assess + Dev (Phase-1) + Dev (Phase-2)
Includes Facility-1 and Facility-2
investments
Project value increased by over
$40 MM when Facility-2 included
(uncertainty considered)
P10
Expected Value
P90

17. Option Value of Unconventional Resource Projects
Case Study:
3. Strategic Options:
Strategic Options
Option value of corporate performance contribution
•
Evaluate full option chain (Investments, divestments)
•
Optimize available selections when considered as part of an overall company portfolio of
options (including Base assets)
Project ‘A’
• Leasing
• 2 Year Pilot (6 wells per year)
• Phase-1 Development (capture): 3 – 6 years
(1 – 2 rigs)
• Phase-2 Development (infill): 0 – 5 years
(1 – 2 rigs)

18. Option Value of Unconventional Resource Projects
Case Study:
Strategic Options
Free Cash Flow ($MM)
Project ‘A’
350
300
250
200
150
100
50
Assess
Economics
Options
Dev – Phase 1
IRR = 38%
NPV = $42MM
IRR = 23%
NPV = $391MM
Conditional (Stop)
Divest after Pilot
Pace of Development
Infrastructure investments
Timing / Deferral (pricing)
Acquire
Divest
Dev – Phase 2
IRR = -2%
NPV = -$9MM
Infill development
Pace of Development
Infrastructure investments
Timing / Deferral - HBP (pricing)
Acquire
Divest
2023
2021
2019
2017
-100
2015
-50
2013
0

19. Option Value of Unconventional Resource Projects
Case Study:
Strategic Options
Stop
Assessment
No
Stop
Pilot
Yr-1
Results
Continue? Yes
Yr-2
Results
Phase-1 Dev
Early
Results
Pace? Accel
Late
Results
Yes
Divest?
No
Development
Phase-1
Delay
Options
1) Assessment only
2) A + D1
3) A + D1 + D2
4) D1 only
5) D1 + D2
6) D2 only
Divest? No
Phase-2 Dev
Yes
Stop
Late
Results
Development
Phase-2
Yes
Divest? No
Phase-2 Dev

20. Option Value of Unconventional Resource Projects
Case Study:
Strategic Options
ACME Company ‘Base Performance & Objectives
Reserve Growth
> 15% per year
Objective: Deterministic
Constraints:
Capex < $300MM per yr
Reserve Growth > 15%
Production Growth > 5%
Export Capacity (as depicted)
NPV = $2,384MM
Production Growth
> 5% per year
Constrained by
Export Capacity
Inventory gap 2015 - 2018
Expected Value

21. Option Value of Unconventional Resource Projects
Case Study:
Strategic Options
ACME Company: With Options Available
High confidence
of meeting
Reserve Targets
through 2018
Objective: Maximize NPV
Constraints:
Capex < $300MM per yr
Reserve Growth > 15%
Production Growth > 5%
Export Capacity (as depicted)
NPV = $2,822MM
60 – 70%
confidence in
meeting
Production targets
in 2017 - 2018
60 – 70% chance of
staying under the
export limit through
2018
• Option 2) A-D1 selected
• D2 (infill not selected due to
marginal economics)
P10
Expected Value
P90

22. Option Value of Unconventional Resource Projects
Case Study:
Strategic Options
ACME Company: If D2 ‘Forced’ into the selection
High confidence
of meeting
Reserve Targets
through 2017
Objective: Deterministic
Constraints:
Capex < $300MM per yr
Reserve Growth > 15%
Production Growth > 5%
Export Capacity (as depicted)
NPV = $2,790MM
High confidence
Production with
the exception of
2016 – 2017
(short term assets
still required)
Capacity constraints
2015 - 2017
Value reduction of less than
2% ($32MM)
• Option A-D1 selected
• Option D2 Mandated
P10
Expected Value
P90

23. Leveraging the Option Value of
Unconventional Resource Projects
Unconventional resource projects – many options…
Financial
Exit strategies
$
$
Net
Present
Value
Ancillary
investments
Net
Present
Value
Net
Present
Value
$
$
Marketing
$
Ownership
structures
Development
Plans
Option Portfolio

24. Leveraging the Option Value of
Unconventional Resource Projects
Unconventional resource projects – many options…
Financial
Exit strategies
$
$
Net
Present
Value
Ancillary
investments
Need robust tools and processes to
manage this data at a portfolio level
$
Marketing
Net
Present
Value
Net
Present
Value
$
$
Ownership
structures
Development
Plans
Option Portfolio

25. Leveraging the Option Value of
Unconventional Resource Projects
Conclusions
 The projected value of an asset can vary greatly depending on contingent
decisions (project interactions, dependencies, and uncertainties)
 Consideration of stochastic ranges – leverage uncertainty - exploit future
upside potential (or mitigate downside outcomes)
 Describing dependencies and managing this data as new information is
obtained supports broader, more realistic, and actionable options

26. Leveraging the Option Value of
Unconventional Resource Projects
Unconventional Resources Technology Conference
Denver, Colorado
12 – 14 Aug 2013
Paul D. Allan
Partner
STRATEGY. DECISIONS. SUCCESS.